News

Houston to be One of the Great Oil Hubs

Jul13,2018

Houston is emerging as one of the great oil hubs in the world, and pretty soon it will be outfitted with an oil futures contract, which could cement its position.

Intercontinental Exchange Inc. (ICE) announced plans to launch an oil futures with physical delivery in Houston, and the contract could launch as soon as this quarter, subject to regulatory review. “The Houston delivery point has become the pricing center for U.S. crude oil production and exports, and the new flat price futures contract is designed to serve hedging and trading opportunities in this growing market,” ICE said in a statement.

Houston is now the “central delivery point for U.S. crude,” with proximity to upstream production in Texas, abundant refining and storage capacity along the Gulf Coast, and coastal facilities that have allowed a crude oil export boom over the past two years. The ICE Permian WTI futures contract will provide price discovery, settlement and delivery at Magellan Midstream Partners, L.P.’s terminal in East Houston, ICE said.

“The recent price divergence between Cushing-based WTI and Brent is a reminder that although Cushing is a marker for local crude fundamentals in the midcontinent, it diverges for pricing waterborne U.S. crude,” Jeff Barbuto, Vice President of Oil Markets at ICE, said in a statement.

For decades, Cushing, Oklahoma has served as the main delivery point for U.S. crude. Cushing is often referred to as the “pipeline crossroads of the world,” and was the designated point of delivery for the WTI contract on the New York Mercantile Exchange. Cushing also has the ability to store around 90 million barrels of crude oil, and indeed, the weekly change in inventory figures have become a closely watched metric since the market downturn began in 2014, with specific emphasis on Cushing’s figures.

But the explosion of production from the Permian basin, and especially the lifting of the crude oil export ban by the U.S. Congress a few years ago, has undercut the importance of Cushing as an oil hub. West Texas oil can be funneled to the Gulf Coast and either refined or exported, all without the need to be routed through or stored in Cushing.

U.S. crude exports have surged over the past year and a half, jumping from below 1 million barrels per day (mb/d) in early 2017 to consistently over 2 mb/d this year. In June, exports broke a new weekly record of 3 mb/d.

Oil gushing from Texas and exported through the Gulf Coast has put a premium on oil in Houston, as opposed to oil located inland. The lack of adequate pipeline capacity has also driven a wedge between cargoes on the coast compared to elsewhere. Oil in Midland, located near surging production from the Permian basin, has traded at a double-digit discount to Cushing. Houston then trades at a premium to Cushing.

As the Wall Street Journal notes, investors who want to trade in Houston prices need to track the Cushing WTI price and trade in contracts that track the difference between Cushing and Houston. A new futures contract in Houston would simplify the trade.

“This will help our customers through the process of hedging their risk around those differentials,” Mark Roles, vice president of commercial crude oil at Magellan Midstream Partners LP, told the WSJ. “As more volumes hit the international market, we’re going to see a much stronger need for pricing and hedging,” he said.

New futures contracts face formidable hurdles and are not guaranteed to be widely adopted and traded. But soaring output in the Permian, which will continue to rise after new pipelines come online, will aid the new ICE contract. Meanwhile, new upgrades to export terminals along the Gulf Coast, such as the one underway in Corpus Christi, will also boost U.S. exports, increasing the importance of having prices based on physical delivery at the coast.

"We're in a wait-and-see mode," Tariq Zahir, a crude trader and managing member at Tyche Capital, told Reuters. "Are banks really going to be behind it? Are there going to be large market makers in it? We'll watch it."